A California LLC is a popular business structure in California due to its flexibility, offering the benefits of both a partnership and a corporation. A critical component of establishing an LLC in California is creating an Operating Agreement. This legally binding document outlines the operational procedures, financial arrangements, and other crucial details related to the business.

A California Operating Agreement is not a one-size-fits-all document; it should be tailored to meet the unique needs of its California LLC as well as the number of members (owners) and management structure of the California LLC. To ensure a California Operating Agreement is comprehensive and customized, it is recommended to consult with a corporate attorney experienced with California LLCs.

This article will briefly introduce California LLCs and California Operating Agreements before presenting some of the most important information that may be included in a California Operating Agreement. Please keep in mind that this article provides information about key provisions of some California Operating Agreements and is not intended to be relied upon for all provisions that should be included in a California Operating Agreement.

Introduction of LLCs and Operating Agreements

Before discussing what provisions should be included in a well-structured California Operating Agreement, it is important to understand what a California LLC is and what is a California Operating Agreement.

What is a California Limited Liability Company (LLC)?

A California Limited Liability Company (LLC) is a type of business entity that is legally separate from its LLC owners, known as members. This structure offers members protection from personal liability for business debts, liabilities, obligations, and legal judgments, meaning their personal assets are shielded from any potential business creditors.

California LLCs offer flexible management structure options and potential tax benefits. However, they are subject to an annual franchise tax imposed by the state of California. The formation of a California LLC involves the filing of articles of organization with the California Secretary of State and adhering to certain state-specific regulations and requirements.

What is a California Operating Agreement?

A California Operating Agreement is a required, binding legal document that outlines the operational procedures of a Limited Liability Company (LLC) and sets forth the financial and functional decisions of the business. Every California LLC is required to have an Operating Agreement, however, the California Operating Agreement required need not be a written Operating Agreement.

While not mandatory, it is highly recommended for every California LLC, regardless of the number of members involved. This agreement helps to establish member roles, responsibilities, and ownership interests, providing a clear framework for business operations and protecting the limited liability status of its members. It also provides dispute resolution procedures and outlines how profits and losses are allocated, changes in ownership are handled, and how the LLC is dissolved if necessary. Even though it is an internal document (it does not need to be filed with the Secretary of State), it is legally enforceable in a court of law.

What Should Be Included in a California LLC Operating Agreement?

The following are provisions that should be considered for inclusion in a California Operating Agreement. Keep in mind that a California Operating Agreement appropriate for use with a single-member LLC with only one member is drastically different than a California Operating Agreement for use with a multi-member LLC with more than one member. Similarly, a California Operating Agreement for use with a member-managed California LLC is significantly different than a California LLC appropriate for use with a manager-managed California LLC.

Title, Introduction, and Recital Provisions of a California Operating Agreement

Title of a California LLC Operating Agreement

The title of a California Operating Agreement must identify the document as an “Operating Agreement” for a certain California LLC.

Introduction of a California LLC Operating Agreement

The introduction should state that all current members are entering into the California Operating Agreement and they have agreed to be bound by its terms. The introduction of a California Operating Agreement should also specify the effective date of the California Operating Agreement, which may or may not be the date on which the California LLC was formed by filing Articles of Organization with the California Secretary of State.

Recitals of a California LLC Operating Agreement

The recitals are the introductory statements that explain the purpose and intent of the California Operating Agreement. The recitals may include information such as the name and formation date of the California LLC, its business purpose, and other relevant details about the California LLC.

Organizational Matter Provisions of a California Operating Agreement

Formation of the California LLC

This section of a California Operating Agreement provides detailed information about the formal establishment of the LLC. This includes the date the LLC was officially formed by filing Articles of Organization with the California Secretary of State, that the California and California Operating Agreement shall be governed by the laws of the State of California, and that the rights of the members are set forth in the California Operating Agreement to the extent that the California Operating Agreement does not violate the California LLC Act (more formally known as the ).

Name of the California LLC

Usually, the Name of the California LLC is a straightforward sentence providing the name of the California LLC. However, if the California LLC will adopt any trade names or fictitious business names, these names may also be included in this section.

The name of each Limited Liability Company pursuant to the California Revised Uniform Limited Liability Company Act must include the designation “LLC” or “L.L.C.” or “Limited Liability Company” as the last words of its name.

Principal Business Office, Mailing Address and Registered Agent of the California LLC

This section of the California Operating Agreement should include the principal business office, mailing address, and registered agent information for the LLC. The principal place of business is the primary location where the LLC conducts its operations (and is the address where the primary business license of the California LLC should be registered), although there is no restriction on a California LLC doing business at multiple locations (provided, of course, that the California LLC maintains a business license at each such location.

If the California LLC will maintain a mailing address separate from its principal business office, this may be specified in the California Operating Agreement in this section as well.

The registered agent is an individual or entity designated to receive official legal documents and service of process on behalf of the LLC. This may be any person in the State of California, a registered agent service, or the attorneys at San Diego Corporate Law if they formed the LLC. A registered agent is required for every California LLC, but there are many options regarding who may assume the position of the registered agent.

Purpose and Business of the California LLC

This section of a California Operating Agreement should clearly outline the objective and the type of business that the California LLC will be conducting. It delineates the primary purpose, which could range from providing specific services, manufacturing certain products, or any other legally permitted commercial activities. This purpose does not necessarily limit the scope of the activities of the California LLC to only that which is mentioned, and the agreement can specify that the California LLC may engage in any other lawful business activity. The business description should be broad enough to encompass all potential activities but specific enough to provide clear direction. This section may also specify whether the California LLC is formed for a specific duration or for a perpetual term.

Capital Contribution and Capital Account Provisions of a California Operating Agreement

Initial Capital Contributions to the California LLC

This section of the California Operating Agreement should outline the initial capital contributions made by each member to the California LLC. Capital contributions refer to the value that each member provides to the California LLC at the start, in the form of money, property, or services. The capital contribution of each member should be listed individually, detailing the type and value of the contribution. This section serves to establish the ownership interest of each member in the California LLC, which is typically proportional to their initial contribution.

While monetary contributions are straightforward, contributions of property or services may require an agreed-upon valuation. This section provides a clear record of the initial investment made by each member of the California LLC and establishes the basis for the distribution of profits and losses.

Additional Capital Contributions to the California LLC

This section of the California Operating Agreement outlines the provisions concerning future capital contributions from the members of the California LLC. It specifies the circumstances under which additional contributions may be required, the method for determining the amount of these contributions, and the procedure for making them. This part could also detail the effect of additional capital contributions on the ownership percentages of the LLC, if any.

Capital Accounts of the California LLC

Not all California LLCs are required to maintain capital accounts, depending upon the number of members and taxation type, but when capital accounts are required, this section of the California Operating Agreement should detail the maintenance and management of the capital accounts for each member in the California LLC.

The capital account of each member is a record of their financial contributions and withdrawals from the LLC. The account begins with the initial capital contribution of the member, and it is then adjusted to accommodate additional capital contributions, distributions, and the share of the profits and losses of each member of the California LLC. Typically, these capital accounts are used to determine the distribution of assets if the California LLC is dissolved.

A California Operating Agreement should specify the method for updating the capital accounts, which should comply with the Internal Revenue Code and its regulations.

Withdrawal, Interest, and Priority of Capital Contributions and Capital Accounts of a California LLC

This section of the California Operating Agreement provides detailed terms concerning the withdrawal of capital contributions by members of the California LLC, the accrual of interest on capital contributions, and the priority of the return of capital accounts and contributions by members of the California LLC.

The withdrawal provisions should outline the conditions under which members may withdraw their capital contributions from the California LLC, including any necessary procedures, restrictions, or penalties.

The interest provisions refer to any earnings paid on the capital contributions of members of the California LLC, if any. It should specify whether the California LLC will pay interest on capital contributions, and if so, the rate of interest and the method of its calculation.

The priority provisions involve the order in which members of the California LLC are paid back their capital contributions in the event of a dissolution or liquidation of the California LLC if any such priority is given. It should define the priority levels of different contributions, particularly in scenarios where the assets of the California LLC are insufficient to fully repay all members.

Failure to Make Capital Contributions to the California LLC

This section of the California Operating Agreement details the consequences for the failure of a member of the California LLC to make a required initial or additional capital contribution to the California LLC. It should outline the measures the California LLC and other members can take when a member does not meet their contribution obligation, which could include penalties such as a reduction in ownership percentage, a re-evaluation of voting rights, or even a forced buyout. The agreement might also specify the interest or penalties on late contributions.

Member and Membership Right Provisions of a California Operating Agreement

Membership Interests or Units of the California LLC

This section of the California Operating Agreement should set forth the issuance of membership interests or units in the California LLC. Membership interests represent an ownership interest in the LLC and may be expressed in terms of percentages or units, with units being similar to shares of stock in a California Corporation or California S-Corp.

Furthermore, it should clearly outline the rights and responsibilities associated with these interests or units, and restrictions on these membership interests or units, and if foreseeable, contain provisions for the issuance of additional membership interests or units in the future, the process for doing so, and the impact of such issuances on existing membership interests or units.

Limitation on Liability of Members of the California LLC

This section of the California Operating Agreement outlines the extent to which members of the California LLC are protected from personal liability for the debts, liabilities, and obligations of the California LLC.

Admission of Additional Members of the California LLC

This section of the California Operating Agreement should define the process for admitting new members to the California LLC. It is important to clearly outline the conditions under which new members may be admitted to the California LLC, whether it requires unanimous consent from existing members or a majority vote. Additionally, it should specify any financial obligations, such as capital contributions, that new members are expected to meet upon being admitted as members of the California LLC. The procedure for assessing and adjusting the ownership percentages of existing members to accommodate new members should also be detailed here.

Dissociation of Members of the California LLC

This section of the California Operating Agreement should delineate the terms and procedures upon which a member can dissociate or leave the California LLC. The California Operating Agreement should provide details regarding the methods for calculating the interest of the dissociating member and the terms for settlement of their capital account. Moreover, this section should describe the impact of dissociation on the operations of the California LLC, specifying whether the California LLC will be dissolved or continue to exist with the remaining members.

Voting Rights of Members of the California LLC

This section of the California Operating Agreement provides detailed instructions on the voting rights of each member within the California LLC. It addresses critical issues such as how many votes each member holds, whether the voting rights are proportional to capital contributions, and how votes are carried out, whether it be by simple majority, supermajority, or unanimous decision. Voting procedures, including provisions for proxy voting, should also be outlined. Additionally, this section should clarify the types of decisions that require a vote, such as approval of budgets, amendments to the operating agreement, or admission of new members. Although given a shorter treatment here, the voting rights section is often one of the longest sections in a California Operating Agreement.

Management Provisions of a California Operating Agreement

Management Structure of the California LLC

This section of the California Operating Agreement should clearly describe the management structure of the California LLC. A California LLC may operate on a member-managed or manager-managed basis.

In a member-managed LLC, all members participate in the day-to-day operations and decision-making procedures of the LLC. This includes single-member LLCs with only one member who is also the manager. On the other hand, in a manager-managed LLC, members appoint one or more managers to handle these tasks. This includes a single-member LLC that is not managed by the sole member.

The California Operating Agreement should specify the type of management structure chosen and provide details about the duties and responsibilities of the members or managers involved in managing the LLC.

Identity of the Manager or Managers of the California LLC

This section of the California Operating Agreement should identify who are the manager or managers of the California LLC. In the case of a member-managed LLC, this might simply be a list of all the members (or a statement that all members manage). For a manager-managed LLC, this should include the name(s) of the appointed manager(s). It might also be relevant to include details about the specific roles and responsibilities of each manager, especially in larger California LLCs where tasks and functions may be divided among multiple managers.

Election, Resignation, and Removal of the Managers of the California LLC

This section of the California Operating Agreement should establish the processes for the election, resignation, and removal of the managers of the California LLC.

First, this section of the California Operating Agreement should detail the procedure for electing managers, whether they are chosen from the existing members or externally, and any qualifications or criteria necessary for a person to be selected as a manager.

Second, the protocol for the resignation of a manager should also be outlined to ensure a smooth transition, specifying any notice period required and how the responsibilities of the manager will be reallocated.

Third, this section of the California Operating Agreement should define the circumstances and procedures under which a manager can be removed. This might include situations of misconduct, lack of performance, or other breaches of the obligations of the manager. The method for deciding on the removal, such as a vote among members, must also be expressly included.

Duties and Limitations on the Powers of the Managers of the California LLC

This section of the California Operating Agreement should expound upon the roles, responsibilities, and boundaries of the managers. The duties of the managers should be thoroughly detailed and may encompass a range of tasks such as strategic decision-making, day-to-day operations management, financial planning and budgeting, and legal compliance.

In a manager-managed LLC, these duties might be considerably extensive, encompassing all operational and administrative aspects of the California LLC. In a member-managed LLC, the duties may be shared or distributed among the members, and in such cases, the specific roles each manager is expected to fulfill should be clearly stated.

In addition, it is important to distinctly define the limitations on the powers of the managers. This portion should establish checks and balances to prevent potential misuse of power. Some decisions, for instance, may require the approval of the members, or a supermajority vote, rather than being solely at the discretion of the managers.

Any restrictions on the managers should be explicitly stated. These might include limitations related to signing contracts of a certain size, hiring or dismissal of staff, or making significant changes to the operations of the California LLC without the consent of the members. This section should ensure that the managers operate within the ambit of their authority while promoting the best interests of the California LLC and its members.

Liability of the Managers of the California LLC

This section of the California Operating Agreement should clarify the extent and limitations of the liability of the managers of the California LLC. It should detail scenarios where the managers would be held personally liable for their actions or decisions and circumstances under which the liability is limited or waived.

In general, managers of a California LLC are not personally liable for the debts, liabilities, and obligations of the California LLC. However, certain actions such as fraud, illegal activities, personal guarantees, or failure to treat the LLC as a separate entity could result in personal liability.

This section may also include indemnification provisions. Indemnification means that the California LLC will cover certain losses or damages that the managers might face as a result of performing their duties. The terms and conditions under which the California LLC will indemnify the managers, the process for claiming indemnification, and any exclusions or limitations to this indemnification should be explicitly stated.

It may also be beneficial to discuss the availability of liability insurance for managers, which can provide additional protection against potential lawsuits or claims. The decision to take out such insurance and the costs involved could be a matter decided by either the members or the managers of the California LLC depending on the provisions of the California Operating Agreement.

In all respects, this section should reinforce that managers are expected to act in the best interest of the California LLC, adhering to a standard of care and fiduciary duty, and that deviation from these standards may result in personal liability.

Allocation of Profit and Loss and Distribution Provisions of the California Operating Agreement a California LLC

Allocation of Profit and Loss of the California LLC

This section of the California Operating Agreement should define how the profits and losses of the California LLC are divided among the members and their capital accounts. This allocation is typically in proportion to the membership interest or units of each member of the LLC, however, the Operating Agreement may stipulate a different method such as defining a percentage interest that is different than the membership interest or units or base allocations on capital account balances.

This section should also specify when and how often such allocations will be calculated. These allocations are for tax purposes and may not necessarily correspond to the actual distributions made to members. Furthermore, this section should detail the procedures for handling losses, particularly if losses exceed the initial and additional capital contributions to the California LLC of a member.

Distributions to Members from the California LLC

This section of the California Operating Agreement should stipulate the procedures and guidelines for distributing profits to members. The distribution plan may be based on membership interest, capital account balances, or any other metric as defined by the California Operating Agreement. It should outline when these distributions occur, whether monthly, quarterly, annually, at the discretion of management, or at some other frequency.

The process for calculating the distribution to each member of the California LLC should be detailed, noting that the distribution amount might not precisely mirror their share of profits as determined by the allocation of profit and loss.

There might be restrictions or requirements established by the available cash flow, debt obligations, or other financial considerations of the California LLC. Any limitations on the distributions should be outlined, including restrictions imposed by applicable laws or regulations, safeguards to prevent the insolvency of the California LLC, or restrictions on distributions to members with a negative balance in their capital account.

Restrictions on Transfer Provisions of a California Operating Agreement

Restrictions on Transfer of a Membership Interest or Units of the California LLC

This section of the California Operating Agreement should specify the rules and limitations regarding the transfer of a membership interest or units in the California LLC. It should clarify whether members are allowed to sell, assign, donate, or otherwise transfer their ownership stake in the California LLC to another individual or entity.

The agreement may require that transfers are subject to the approval of the other members or managers, or may require the prospective transferee to meet certain criteria or qualifications.

Restrictions may also be put in place to protect the financial stability or tax status of the California LLC. These restrictions could include restrictions on transfers to individuals or entities in certain locations, or transfers that would result in a change in the tax classification of the California LLC. Rules could also be established to control transfers in certain scenarios, such as the death, divorce, or bankruptcy of a member.

This section serves to preserve the continuity of the California LLC, protect the interests of the existing members, and maintain the desired management structure and financial stability of the entity.

Permitted Transfers of a Membership Interest or Units of the California LLC

In this section of the California Operating Agreement, the conditions under which the transfer of membership interest or units is permitted should be clearly determined. It should address scenarios such as transfers of a membership interest or units of the California LLC to trusts for estate planning purposes or transfers to existing members not subject to transfer restrictions or the approval of the members or managers.

The agreement may allow for automatic transfers upon certain events, such as the death of a member, or it could require approval by the remaining members or managers under these circumstances.

The California Operating Agreement should clarify the procedures for executing a permitted transfer, including any notice requirements, documentation, and steps to update the California Operating Agreement and any other official records.

Right of First Negotiation for a Membership Interest or Units of the California LLC

This section is optional and not always included in a California Operating Agreement, but when used it should detail the process by which a member may negotiate the selling of their membership interest or units in the California LLC before offering it to third parties. The Right of First Negotiation stipulates that the member intending to sell must first negotiate in good faith with the existing members or managers of the California LLC.

The section should clearly articulate the process for initiating this negotiation, laying out any requirements for initial notice to other members of the California LLC and establishing a reasonable time frame within which these negotiations should take place.

If the existing members or managers do not wish to purchase, or if a satisfactory agreement cannot be reached within the stipulated negotiation period, the section should provide guidelines for selling the membership interest or units of the California LLC to a third party. It should also outline any restrictions on the sale to third parties, especially that the third party shall enter into the California Operating Agreement of the California LLC as a condition of their purchase.

Rights of First Refusal for a Membership Interest or Units of the California LLC

This section of the California Operating Agreement should clearly establish the conditions and procedures under which existing members or managers of the California LLC have the right to purchase the membership interest or units of a selling member before they are offered to a third party. This right of first refusal is often included to allow the current members to maintain control over the membership of the California LLC.

The section should detail the process to be followed when a member wishes to sell their interest, including the requirement for the selling member to provide a written offer to the existing members outlining their intention to sell and the terms of the sale. The existing members should then be given a defined period within which to accept or decline the offer. If the existing members decline or fail to respond within the specified time frame, the selling member may proceed with the sale to a third party.

Accounting, Record Keeping, and Reporting Provisions of a California Operating Agreement

Books and Records of the California LLC

The section of the California Operating Agreement should define the requirements and procedures for maintaining and accessing the official records of the California LLC and address the responsibility for the preparation and retention of these records, usually the task of a designated member or manager, or a hired professional. It should also detail where these records will be stored and how often they will be updated, as well as the process for members to inspect and copy these records.

Books and records typically include financial statements, a list of members and managers, tax returns, and other important documents related to the operation of the business of the California LLC. This section should also specify whether the California LLC will use the cash or accrual basis accounting method, the fiscal or calendar year for the California LLC, and the requirement for an annual audit or review, if any.

Reporting Requirements of the California LLC

This section of the California Operating Agreement should outline the specific reporting obligations that the California LLC must meet. These reporting requirements typically include requirements for periodic financial reports, tax filings, and any other reports that may be required by federal or California law or the terms of the Operating Agreement. The interval at which these reports should be prepared and submitted should be clearly specified, and these are generally established by the California Corporations Code.

This section should also outline who is responsible for the preparation and submission of these reports. Usually, this responsibility falls on the managers or designated members of the California LLC, however, the California LLC may hire an independent accountant or another professional to handle these tasks.

Dissolution Provisions of a California Operating Agreement

Approvals Required for the Dissolution of the California LLC

This section of the California Operating Agreement should address the specific approvals required to initiate the process of dissolving the LLC. Typically, the dissolution of an LLC requires the agreement of a specified majority of the members. The percentage required should be clearly outlined in this section and could range from a simple majority to a unanimous vote, depending on the terms of the California Operating Agreement for the California LLC. However, dissolution of the California LLC may not require the approval of the members upon the happening of certain events set forth in the California Operating Agreement as triggers requiring dissolution of the California LLC.

Winding Up and Distributions After Dissolution of the California LLC

This section of the California Operating Agreement should elaborate on the procedures for winding up the business operations of the California LLC after dissolution. It should detail the sequence of steps to be taken, normally beginning with the settling of the debts, liabilities, and obligations of the California LLC, after which the remaining assets may be distributed among the members according to their respective membership interests, units, or as otherwise established in the Operating Agreement.

This section should also outline any obligations the LLC might have to undertake before the distribution of remaining assets, such as selling assets, settling disputes, or filing final tax returns. Additionally, it should specify who will be responsible for conducting the winding-up process. This is often one or more of the existing members or managers, or a designated third party.

Investment Representation Provisions of a California Operating Agreement

The “Investment Representation” section of a California Operating Agreement outlines the terms and conditions governing investments in the LLC. If the California LLC anticipates investments from third-party investors, this section should detail specific rules related to investor rights, duties, and liabilities. Such rules should include representations and warranties from the investor regarding their understanding of the risks involved in their investment, whether they meet any applicable investor suitability standards, and whether they are making the investment for investment purposes only and not for the distribution of the membership interests or units they acquire, and otherwise comply with any applicable federal, state, and California securities laws and regulations, such as those mandated by the Securities and Exchange Commission and the California Department of Financial Protection and Innovation.

Consent of Spouse or Registered Domestic Partner

While not within the four corners of a California Operating agreement, the Consent of Spouse or Registered Domestic Partner should be executed by the spouse or registered domestic partner of each member of the California LLC.

A Consent of Spouse or Registered Domestic Partner is a consent that pertains to the legal rights of a spouse or registered domestic partner of a member of a California LLC in the event of death, dissolution of the marriage, or dissolution of the registered domestic partnership. The Consent of Spouse or Registered Domestic Partner acknowledges that the spouse or registered domestic partner is aware of, and consents to, the terms of the California Operating Agreement.

This consent is essential because, in California, all properties acquired during the marriage or registered domestic partnership are considered community property, and both parties have a right to these assets. Thus, in the context of the California LLC, if the spouse or registered domestic partner of a member has not explicitly consented to the California Operating Agreement, they could potentially assert rights over the membership interest or units of their spouse or registered domestic partnership under community property laws in the event of a divorce, dissolution, or death. Despite not being a technical part of the California Operating Agreement, including this consent adds a layer of protection to the California LLC and its members by mitigating potential disputes or claims related to community property rights.

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